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9.Quad Enterprises is considering a new three-year expansion project that requir

ID: 2760800 • Letter: 9

Question

9.Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.43 million. The fixed asset will be depreciated straight-line over its three-year tax life, and the fixed asset will have a market value of $281289 at the end of the project. The project is estimated to generate $2102812 in annual sales, with costs of $805313. The project requires an initial investment in net working capital of $361924. If the tax rate is 37 percent and the required return on the project is 11 percent, what is the project's NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to the nearest dollar amount. Omit the "$" sign and commas in your response. For example, $123,456.78 should be entered as 123457.)

Explanation / Answer

Solution:

(i) Present Value of Cash Outflow (Cost of Project)

Investment Amount

$2,430,000

Add: Working Capital requirement

$361,924

Present Value of Cash Outflow

$2,791,924

(ii) Present Value of Cash Flows

Estimated Annual Sales

$2,102,812

Less: Cost of Sales

($805,313)

Profit Before tax and depreciation

$1,297,499

Less: Depreciation (Note 1)

($716,237)

Profit Before Tax

$581,262

Less: Taxes @ 37%

($215,067)

Profit After Tax

$366,195

Add: Depreciation

$716,237)

Annual Cash Flow

$10,82,432

Present Value Interest factor for Annuity (11%, 3)

2.4437

Present Value of Cash Flow ($10,82,432 x 2.4437)

$2,645,155

Add: Present Value of Salvage Value at the end of life after tax (0.73119 x $281,289 x (1-0.37)]

$129,576

Add: Present Value of Working Capital Released at the end of project life ($361,924 x 0.73119)

$264,635

Total Present Value of Cash Flow ($2,645,155 + $129,576 + $264,635)

$3,039,366

Note 1: Annual Depreciation as per SLM = (Cost of Asset – Scrap Value) / estimated life = ($2,430,000 - $281,289) / 3 = $716,237

Note 2: In case the project requires working capital, then if nothing specify in the question about Working Capital release, then it is assumed that working capital should be released at the end of project life.

Note 3: Salvage Value is taken after tax.

(iii) Net Present Value

Total Present Value of Cash Flow

$3,039,366

Less: Present Value of Cash Outflow

($2,791,924)

Net Present Value (NPV)

$247,442

Investment Amount

$2,430,000

Add: Working Capital requirement

$361,924

Present Value of Cash Outflow

$2,791,924